April 30, 2015

WSJ: How Cable Lost the Remote

"Everybody loves watching sharks,” Discovery Communications founder John Hendricks quipped at a media conference years ago, “and people will watch anything about Nazis. If we could just get sharks to fight Nazis, we would mint money.” He needn’t bother.

Discovery CEO David Zaslav, who oversees the cable empire that includes the Discovery Channel, TLC and Animal Planet, pulled in $156 million in compensation last year, up from $33 million in 2013. Expect that to change.

This isn’t a rant against CEO pay, but it is irritating that you and I helped pay Mr. Zaslav’s salary when most of us don’t use his product. One of Discovery Channel’s highest-rated shows, “Naked and Afraid,” which documents partially blurred naked people living in the wild for 21 days, boasted 2.9 million viewers last year out of 100 million households that pay for the channel through basic cable. Discovery Communications’ $3 billion in U.S. sales for 2014 means that each household paid about a buck to Mr. Zaslav. A nice gig if you can get it.

But this is how the cable cabal works—or worked. ESPN’s recent decision to sue Verizon over cable-package placement is one indication that change is afoot.

With a local monopoly, cable operators dictate packages and pricing, markets be damned. Satellite rarely competes on price. Cable bills have grown at almost triple the rate of inflation over the past two decades, according to the Federal Communications Commission. But in April, Verizon announced Custom TV, which offers a few basic channels and additional channel packs: Kids, Pop Culture, Lifestyle, Entertainment, News & Info, Sports Plus and Sports. The Discovery Channel is no longer basic cable. Neither is ESPN. Uh oh.

How did the unraveling happen? Three decades ago, Discovery traded half of the company to cable operator TCI in exchange for inclusion in basic cable, along with a nickel a month in fees for each subscriber. Today Discovery Channel charges $1.21 a month for each subscriber, according to the financial information firm SNL Kagan.

Sports channels are worse. Disney’s ESPN charges more than $6 a subscriber, up from $2.50 less than 10 years ago. Time Warner’s TNT, which carries the NBA, is almost $2 a month. In October the NBA signed a $24 billion broadcast deal with ESPN and Turner Sports, up 180% from the previous deal. You can bet those fees are headed up.

Subscribers bear the cost: The average monthly cable bill is $64 a month, and DirecTV’s is $107. Time Warner CEO Jeff Bewkes has said that less than half of those with a cable bundle watch sports, and so ESPN would implode without the basic cable deal. Cable channels accounted for one-third of Disney’s revenue in 2014, and half of profits. No wonder the company is suing.

The cable gusher may still be five years away, but here are a few places you can see the dripping.

The largest cable operator, Comcast, still owns cable channels and NBCUniversal, but the rest of the industry has mostly separated. Time Warner split off from Time Warner Cable in 2007. Though Comcast wasn’t allowed to buy Time Warner Cable, someone else will, perhaps Charter, Cox, AT&T or Verizon, all of whom are in the distribution game. Disney, Viacom and Fox own content. While channels look for wide distribution, both cable and broadband are more than capable of delivering video. After all, it’s just data.

For instance, if you’re under 30, you probably use Netflix, Amazon or Hulu to stream content straight to your tablet. About 30 million homes have HBO or Showtime, meaning 70 million don’t. HBO Now lets you stream shows for $15 a month. This isn’t a disruptive price, but at some point the company could drop the number to steal customers from cable. DISH satellite offers SlingTV for $20 a month. Few would ditch cable at that rate, but at $10 a month? It starts to look tempting.

Then there’s piracy. Seconds after shows hit the air, they are available on torrent sites. The top Pirate Bay downloads in the past few days were “Game of Thrones,” “Gotham” and “Better Call Saul.” Who needs cable? Most TV is dull and someone will chop up the comedy shows and upload the highlights to YouTube so you can catch up while you’re bored at work.

Today’s wild card is mobile. The 4G network is almost good enough to stream TV on a phone, and Wi-Fi could become a distribution channel. The big digital players are starting to see the value. Facebook, for instance, recently announced $1 billion of infrastructure spending, including Internet-beaming drones to help expand global Internet access, with—you guessed it—free or preferential access for Facebook.

Google has three mobile initiatives: Project Loon, a network of high-altitude Internet balloons; Google Fi, which offers mobile service by renting Sprint and T-Mobile networks; and gigabit Ethernet called Google Fiber. Amazon is rumored to be working on a wireless network. Apple owns mindshare, if not marketshare, in mobile and can partner with everybody.

While cable languishes, mobile will borrow the Discovery Channel’s lucrative model of coupling content and distribution. Don’t expect wireless network operators and Internet service companies to stay separate; Google owning AT&T is not far-fetched, and neither is Facebook owning Verizon or even a piece of China Mobile. Competition will get fierce. That will be a Shark Week worth watching.